California Cannabis Leasing: Federal Enforcement Is Not The Only Concern

The current state of enforcement in California tends to be dominated by headlines about the Department of Justice, Jeff Sessions, the DEA, and the Controlled Substances Act. And for good reason—under the constitution, federal law is the law of the land, and commercial landlords and tenant alike should study federal enforcement guidelines closely. Lease agreements should account for those guidelines by mandating clear tenant compliance obligations as well as providing for appropriate remedial measures in the event those obligations are not followed.

But California’s commercial cannabis legal regime does not exist under or because of federal law—rather, it is a creature wholly of state and local law. California statutes, state agency regulations, and city and county ordinances, zoning plans, and land use restrictions are what form the flesh and bones of California cannabis law. As a result, most risks affecting commercial tenancies materialize not from threatened federal action, but from issues surrounding compliance with state and local law, and related enforcement actions. Commercial cannabis leases in California should therefore primarily account for and address these risks. Following are examples of some specific issues that should be addressed in the marijuana business leasing process.

     1.     State and local enforcement actions. 

After twenty years of a mostly hands-off approach to the medicinal cannabis industry, it has proven difficult for the state to properly incentivize cannabis businesses to apply for licenses and comply with California’s new cannabis regulatory regime. And the ones that have done so are currently at a relative disadvantage in that they cannot deduct business expenses for tax purposes, must pay the costs of acquiring permits and licenses, and must maintain compliance with all applicable laws (which continue to change not infrequently). With the exception of a legislative budget dispute on how to fund it, the state is set to ramp up enforcement efforts against unlicensed entities. What this means for cannabis tenancies is that leases should include, among other things: strict compliance obligations that track the status of local and state regulation; a clear licensing and permitting timeline with built-in contingencies for failure to acquire, maintain, or comply with any relevant government approvals; and early termination contingencies for enforcement actions brought by local or state agencies. While these are similar to federal enforcement contingencies, they can go further by tailoring to locality-specific requirements, and referencing specific provisions of tenant permits when available. Whereas the industry is rife with speculation about federal enforcement priorities, there is a voluminous amount of information about state and local laws applicable to the cannabis industry in California, and tenancies should take advantage of that knowledge to minimize risk of adverse enforcement actions.

     2.     Change in local law rendering tenant’s operation a nonconforming use.

Interestingly, this is often something that I have had to convince clients is actually a real risk to consider: a locality passing a commercial cannabis ordinance, and then following it with a ban, but not before issuing cannabis permits and happily accepting the fees. This first became an issue in states such as Washington where legalization occurred early on, and it’s now becoming an issue in California, inevitably leading to enforcement of those post-hoc bans and ensuing criminal charges and civil litigation. Whether or not a ban is ultimately upheld in court, it creates uncertainty and immediate enforcement concerns for landlords and tenants. Leases should account for this risk by building in early termination contingencies for changes in local law, or, depending on what the parties negotiate, indemnification and attorney’s fees provisions in the event one of the parties decides to challenge the change in law.

     3.     Zoning, land use, and water rights.

No matter what the federal government might say or do in the future, every locality will always have laws that govern how land within its borders may be used, and how water may be used on that land. While such laws are not unique to commercial cannabis, laws that apply to cannabis in California are, and they vary between every city and county. Of course, there are also private land use restrictions such as CC&Rs and easements that may affect a cannabis use. In every commercial tenancy there are risks that such laws and restrictions would prevent the tenant from performing the permitted use, perhaps due to an overlooked setback requirement, or a property that’s zoned for one cannabis use but not another, or a conservation easement on farmland whose terms require compliance with “all laws” (including federal), or an inability for the tenant to divert enough water or property discharge waste. These issues should be part of a tenant’s due diligence process prior to singing the lease, and responsibility should be allocated accordingly in the lease. But it doesn’t hurt for the landlord to conduct its own analysis during the tenancy vetting process, and the lease can also be structured to allow for early termination if any such unanticipated issues arise, including in the event that any such laws or restrictions change during the tenancy.

What is unique about state and local laws is that they will likely remain active concerns for commercial cannabis leasing no matter what the federal government does in the future. More so than typical commercial tenancies, cannabis landlord and tenants alike will have to continue to account for state and local issues that present risks to the tenancy, and all parties will have to stay abreast of laws and regulations as they continue to change.

For more on California cannabis leasing, check out the following: